Gold stocks have
been pummeled mercilessly this month, their price action looking
almost apocalyptic. The psychological stress spawned by such
extreme weakness is intense, breaking the wills of this sector’s few
remaining bulls. This week their selling cascaded into a full-blown
capitulation, a mass surrender by weary investors. While
exceedingly miserable, these events flag major long-term bottoms.

Over the course of
gold’s powerful secular bull, the gold stocks have been a sentiment
roller coaster. Early on their gains were enormous, gold stocks
even rocketed higher while the general stock markets plunged in a
brutal cyclical
bear. Though they were nearly obliterated in 2008’s
once-in-a-lifetime stock panic,
as expected
they soon soared in a massive recovery. Last autumn they hit new
all-time highs.

But since the
flagship gold-stock index (HUI) peaked in September, this sector has
really fallen out of favor. Selling begets more selling, technical
levels are broken, sentiment waxes increasingly bearish, so gold
stocks are driven ever lower. In the first couple weeks of May
alone, the HUI plunged 15.2%! Relentless selling leading to abysmal
new lows eventually shakes out all but a bull’s true believers.

Even though the
HUI was already hyper-oversold by its own bull-to-date standards, it
plunged another 8.6% over 3 trading days ending this past Tuesday.
Such massive selloffs from already-deep lows are a hallmark of
capitulation. The frenzied exit of traders throwing in the
towel in great frustration leads to selling exhaustion. Everyone
susceptible to being scared into selling anytime soon is squeezed
out.

But this leaves
only buyers, so the nearly total absence of sellers after a
capitulation ignites a big surge. This major reversal usually
matures into a strong upleg. Thus capitulations, the wholesale
abandonment of a sector by traders pushed to their emotional limits,
are one of the greatest buy signals. And this week’s intense
technical weakness and extreme sentimental distress in gold stocks
sure looked like one.

While
capitulations are psychological events, collective emotions can’t be
measured. But the miserable impact of excessive fear and disgust is
readily apparent in price action. So the mass surrender of
capitulation is easily identifiable on charts. And the recent
cascading selloff from already-low gold-stock levels is perhaps most
vividly illustrated across multiple gold-stock measures in indexed
terms.

The first is the
HUI, long the leading gold-stock index closely followed by investors
and speculators. Officially known as the NYSE Arca Gold BUGS
(Basket of Unhedged Gold Stocks) Index, it currently includes 16
elite major gold miners. But in this increasingly ETF-dominated
world, the GDX
gold-stock ETF is vying for the HUI’s throne. This Market
Vectors Gold Miners ETF was launched in May 2006.

Today GDX has 31
component stocks, but despite its broader reach it still trades very
similarly to the HUI due to the way each metric’s major components
are similarly weighted. For a variety of reasons beyond the scope
of this essay, I suspect GDX will eventually replace the HUI as this
sector’s measuring rod of choice. Its little brother, the
GDXJ
junior-gold-stock ETF, offers the best view of the latest
capitulation.

This Market
Vectors Junior Gold Miners ETF was launched by Van Eck Global just
like GDX, but quite a bit later in November 2009. While GDX focuses
on major gold miners, GDXJ offers a valuable window into the
volatile world of much-smaller producers and explorers. It
currently has a whopping 86 components, dominated by small
market-cap companies. Juniors were ground zero for this
capitulation.

And of course no
look at gold stocks would be properly framed without considering
gold. This metal’s price naturally drives the long-term
profitability and hence ultimately the stock prices of the companies
that produce it. The fact that gold stocks plunged so dramatically
relative to gold remaining high and strong greatly enhances the odds
for success in this post-capitulation gold-stock buying opportunity.

With 4 data series
on 4 different scales, the only way to parse them all at once is by
indexing them. This makes them perfectly comparable in percentage
terms. I set each individual index to 100 as of the HUI’s recent
all-time high in early September 2011. From there a 10% move higher
or lower takes any index to 110 or 90 respectively. This first
chart establishes some strategic context for identifying
capitulations.

Because gold’s
fortunes are gold stocks’ only real long-term fundamental driver, I
zeroed the vertical axis so this latest capitulation can be
understood relative to gold. Gold has had a rough time lately, no
doubt. A relentless parade of economic fears out of Europe, Asia,
and the US, as well as traders realizing the Fed isn’t going
to launch a third round of inflationary
quantitative
easing anytime soon, really hit gold.

Since its latest
interim high in late February, gold was down 13.9% as of this week.
While that isn’t a trivial selloff, gold was still only dragged back
to a 10-month low. Even though gold fell under $1550 and spooked
excitable traders, you have to remember that before a year ago such
levels had never even been seen before! Technically gold has
merely been consolidating high after getting very
overbought last
August.

But the gold-stock
investors and speculators have wildly overreacted to this relatively
minor gold selloff in the grand scheme. Over this same short
11-week span, the HUI was pounded 31.5% lower. To give you an idea
of how disproportionate this was compared to gold, the HUI hit
27-month lows this week! There is a huge disconnect between gold
slumping to 10m lows and its miners being pummeled to 27m ones.

And it gets even
worse. This week’s capitulation beat the flagship HUI gold-stock
index back down near 375. The first time the HUI exceeded 375 in
this secular gold bull was way back in September 2007. Where was
gold then? It had just approached $720 for the first time in this
bull! So this week, gold stocks were trading as if gold was at $720
when this metal was really 2.1x higher near $1540! Crazy.

As you can see
above, the indexed blue HUI line and white GDX line are virtually
identical. But the red GDXJ performance is radically different.
This premier junior ETF was obliterated this week, falling to the
lowest levels it’s ever seen since its birth in November 2009. The
highly-speculative juniors are a great weathervane for gold-stock
psychology in general, and they were wildly out of favor this
week.

Gold juniors have
long been our specialty at Zeal, and we own plenty of them thanks to
gold stocks languishing at stock-panic levelsrelative to gold
in recent months. During this week’s capitulation, even though many
of these stocks were already near major multi-year lows, some
plummeted by 10% to 20% on a single trading day with no news!
Extreme selling from lows, for no reason, is a capitulation.

And the
jaw-dropping magnitude of the recent gold-stock selloff is
crystal-clear on this zeroed indexed chart. The gold stocks, big
and especially small, have just cascaded lower in a waterfall
decline. The psychological angst, pain, and pressure such a brutal
selling event spawns are nearly impossible to resist for all but the
most battled-hardened contrarians. Gold stocks have just fallen off
a cliff lately.

Such immense
selling has only been seen one other time before in recent history,
during 2008’s epic stock panic. Gold stocks plummeted then, again
dramatically outpacing gold’s own decline. They ended up at
absurdly-oversold levels that I pointed out
at the time
were a once-in-a-lifetime buying opportunity. And indeed this
sector soon started surging, the HUI more than quadrupling in
the next 3 years!

The stock-panic
plunge leading into that amazing time to fight the scared herd and
buy aggressively is provocatively the only other recent event
remotely comparable to this latest gold-stock capitulation. Extreme
weakness, shaking out every last trader who can’t withstand the
intense pressure of fundamentally-sound positions plunging for
emotional reasons, paves the way for enormous rallies.

Could the HUI
actually quadruple again in the coming 3 years? Absolutely. As
I’ve discussed in many essays since the stock panic, this index had
an average ratio
to gold of 0.511x in the 5 years before 2008’s stock panic.
This week the HUI/Gold Ratio plunged to 0.244x, levels only
briefly seen during the panic’s dark heart. If gold merely
stays flat near its recent lows, the HUI would have to more than
double just to regain its pre-panic HGR!

But given gold’s
bullish
fundamentals globally, this metal certainly isn’t likely to
languish near lows in the coming years. With
mine supply
growth still heavily constrained and investors including central
banks still seriously under-allocated to this unique asset, gold’s
secular bull ought to have years left to run yet. And by the time
we see that popular-mania parabolic
gold-bull climax,
the HUI will likely easily more than quadruple.

This next chart
zooms in to highlight this latest gold-stock capitulation. The
selling in the gold stocks, especially the high-potential juniors,
was wildly disproportionate relative to what has happened in gold.
Once again the HUI, GDX, GDXJ, and gold are all indexed to 100 as of
the day the HUI’s all-time high was achieved last September. The
sheer carnage driven by this irrational gold-stock capitulation is
unreal.

Since their latest
highs, the HUI and GDX plunged by 40.8% and 41.0% as of this week.
This is ridiculous given gold was only down 18.8% from its own
all-time high a little earlier. But the selling in the major gold
miners was dwarfed by the apocalyptic plunge in the juniors. From
its latest interim high last April, GDXJ was down a stomach-churning
57.8% as of this week! Juniors are getting obliterated!

These
highly-speculative stocks are tasked with the critical mission of
discovering and starting to mine new gold deposits to feed the
world’s voracious investment demand for this yellow metal. And just
like larger miners, the price of gold determines the profitability
of these hard labors. And universally in the stock markets, any
company’s long-term profits ultimately drive its long-term
stock-price levels.

When GDXJ peaked
in early April 2011, gold had just hit $1475 for the first time in
history. And given this ETF’s ascent into that interim high
mirroring but only modestly outperforming the HUI, that valuation of
gold-stock prices relative to gold was certainly conservative. But
fast-forward to this week, and this basket of elite gold juniors was
58% lower while gold itself actually rose 4% over this same
span!

Why is the entire
gold industry valued between 40% to 60% less when gold is
gradually inching higher even at its recent lows? You have to agree
this makes no sense at all fundamentally, it is incredibly illogical
and irrational. We continue to do extensive research into gold
juniors at Zeal, and they continue to find excellent new deposits
and bring great new mines online just like they always have.

In fact besides
the lack of investor interest (which makes it very difficult to
raise the capital needed to explore and mine), juniors as a whole
have no new industry-wide operational problems or impairments. The
entire junior-gold rout culminating in this latest capitulation is
purely emotional, it has absolutely nothing to do with
fundamentals. Gold-stock investors and speculators are simply
scared, end of story.

The same is true
in the major gold miners, where we’ve done
extensive research
on their profit margins. In both gross-margin and absolute terms,
gold-mining profits continue to rise dramatically thanks to these
sustained high gold prices. Late last August heading into the HUI’s
all-time high, its components had a market-capitalization
weighted-average price-to-earnings ratio of 23.3x earnings. By the
end of April, it had plunged to just 13.2x!

So it’s not like
gold miners aren’t earning money anymore with gold near $1500
instead of $1800. They are actually earning profits hand over fist,
and are seriously cheap even by general-stock-market standards.
2011 was gold miners’ most profitable year ever by far, when gold
averaged $1573 on close. So far this year, despite all the bearish
gold hysteria, gold has averaged $1672! This is 6% higher.

Regardless of
which angle you choose to view gold stocks from, their steep selloff
culminating in this week’s capitulation climax makes zero sense
fundamentally. The hard truth is gold stocks have been sold
wildly disproportionately to gold’s own weakness merely because
investors and speculators succumbed to their own unjustified fears.
Capitulations are always irrational, emotional events.

The extreme fear
and disgust generated by these exceptional selling climaxes force
out every last trader that lacks emotional discipline. Sadly all
many investors and speculators can think about is the last couple
weeks’ technical action. They can’t be bothered with researching
gold-stock fundamentals, or with learning the essential contrarian
discipline of keeping their own emotions in check. So they
surrender.

The capitulation
event itself forces all the weak hands to exit at once, they sell
low in their rush to realize huge losses. But once they are gone,
the buyers regain control. And with everyone too scared shaken out,
sentiment quickly swings back away from extreme fear and disgust.
So capitulations nearly always spawn huge rallies and uplegs, major
advances are born out of the deck-clearing throes of despair.

And indeed one
appears to be starting. As I pen the draft of this essay on
Thursday, gold and the gold stocks are surging dramatically out of
Tuesday’s and Wednesday’s hyper-oversold lows. Even weak general
stock markets weren’t enough to retard early-day gold and HUI
rallies on the order of 2.5% and 6.0%! The sharp bounce after a
brutal cascading selloff offers confirmation the capitulation is
over.

At Zeal we’ve been
actively trading gold stocks for over a decade, earning a fortune
through every kind of extreme sentiment condition you can imagine.
This week’s capitulation certainly isn’t the first time gold stocks
have been loathed. Like every other sector, they gradually
oscillate from in favor to out of favor and back again. If you can
steel yourself to fight the crowd, be brave when others are afraid,
you can buy them at incredible bargains occasionally. And today
looks like just such a rare opportunity.

Since the vast
majority of selloffs don’t climax in full-blown capitulations, such
events are inherently unpredictable. So we did plenty of buying
earlier in this gold-stock selloff. But all our positions are
deeply-researched elite high-potential gold stocks with outstanding
fundamentals. You can learn about them in our popular
fundamental reports.
Our latest on gold juniors are full of awesome companies trading at
irresistible bargains.
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learn about these elite juniors, and buy cheap!

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The bottom line is
gold stocks appear to have just suffered a full-blown capitulation.
For no fundamental reason whatsoever, they cascaded sharply lower
from major lows. Traders simply let their own fear and anxiety
overpower their reason, so all the weak hands rushed for the exits
to end the pain. While miserable to suffer through, these rare
extreme selling climaxes mark major long-term bottoms.

So if you can keep
long-term fundamentals in focus and tame your fear, capitulations
are the worst-possible time to sell and an amazing time to buy.
Though they feel like hopeless death spirals, this very despair
quickly burns itself out. And with buyers greatly outnumbering
sellers, prices soon rocket higher to undo the tremendous technical
damage of the capitulation. Gold stocks are due to rebound sharply.